Tuesday, August 27, 2013

Krugman and DeLong Smackdown Bob Murphy

This is just a terrible mess.

Bob Murphy again does what he has a habit of doing, arguing from a non-Austrian perspective to attack non-Austrian economists, in this case Brad DeLong, and thinking he is somehow advancing the Austrian cause. He readily admits this is his method of attack on DeLong. He writes:

I’m doing this whole post within DeLong’s framework, just to show he’s making a non sequitur even on his own terms.

BUT, the main problem with DeLong's argument is that he is using improper methodology. No Austrian, as an Austrian, would ever discuss "potential GDP." There is a problem with the use of GDP as a measure in the first place, never mind "potential GDP".

The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.

(Note: For a further discussion on the fallacies inherent in GDP calculation, see Frank Shostak; What Is GDP?) Can you imagine Mises going beyond discussing GDP, which he would have a major problem with, to discuss "potential" GDP? Yet, this is the "framework" Murphy uses to debate DeLong.

Got that? The damn framework is wrong and Murphy could have punched DeLong out right there. Instead, Murphy steps into to this never, never land and takes the magical GDP number and leaps further into a super magical "potential" GDP number to attack DeLong.

Does Murphy note, anywhere, that business equipment investment, which ought to fall as capital lifetimes are extended if the pace of trend economic growth markedly slows, has not?

No.

Does Murphy note that the shortfall in residential construction investment has a financial explanation and is not credibly blamed on a lower future potential output growth path?

No.

Does Murphy note, anywhere, that at a 5% real rate of return on capital the reduction in potential as a result of the post-2008 investment shortfall is now (19%-14% fall in investment share) x 4 years x 5%/year return on capital = 1% reduction in potential GDP, which is why I said that the path of growth is not "materially lower" rather than not lower when you compare it to the 5.5% real aggregate demand shortfall relative to trend?

No.

There is an ongoing (and interesting, and insightful) academic discussion of potential GDP and its growth going on. But does Murphy participate in it at all, or recognize its existence?

No.

Tell me how I am to interpret this other than as: "Oh. It's Murphy not doing his homework yet again"?

Note: A lot of what DeLong has to say does not have relevancy from an Austrian perspective, but it does form DeLong's "framework," which for some bizarre reason is the sandbox Murphy has chosen to play in. But, it doesn't stop there. Krugman dumps a pail of sand on top of Murphy also:

Brad DeLong gets very annoyed at Robert Murphy, who ridicules him for not taking into account the effect of low investment on potential output. Brad notes that Murphy apparently hasn’t done the math, which indicates that even the sustained shortfall we’ve had since 2008 (mainly in residential investment) should not have had a major effect.

But it’s actually much worse than even Brad seems to realize. The potential output series he’s using comes from the Congressional Budget Office, which describes its method (pdf):

CBO’s estimate of potential output is based on the framework of a textbook model of long-term economic growth, the Solow growth model. The model attributes the growth of real GDP to the growth of labor (hours worked), capital (an index of capital services emanating from the stock of productive assets), and technological progress (total factor productivity). CBO estimates trends —that is, removes the cyclical changes—in the labor and productivity components by using a variant of a relationship known as Okun’s law. (In principle, other “detrending” methods could be used to extract the trends in those inputs.)

So the CBO already takes into account the effect of a smaller capital stock on potential output. That’s part of the reason CBO’s projections of future potential have in fact been marked down since the crisis began.

General recommendation: before you denounce a reputable economist for making some completely idiotic mistake, do your homework.